Transcript Senior Management Review Meeting November 24, 2010

Preventing Employee Theft,
Embezzlement and AP Fraud
F. Dean Driskell III, CPA, CFF, CFE
FTI Forensic & Litigation Consulting
Tuesday, April 12, 2011
Overview
Introduction to Fraud
Red Flags
Detection, Prevention
and Controls
Case Study
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Page 2
Overview (Cont’d.)
Introduction to Fraud
Red Flags
Detection, Prevention
and Controls
Case Study
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Page 3
Prevalence of Fraud
A report by Kroll found that 85% of organizations
surveyed experienced at least one fraud during 2009. 1
The Association of Certified Fraud Examiners estimates
that 5% of all revenue is lost to occupational fraud. 2
This translates to approximately $2.9 trillion annually. 2
1 Kroll
2
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Global Fraud Report, Annual Edition 2009/2010
“2010 Report to the Nations On Occupational Fraud & Abuse”, ACFE, 2010, p.4
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General Types of Fraud
Asset Misappropriation – involves the theft or misuse of
an organization’s assets (focus of this presentation).
Corruption – Uses their influence in a business
transaction to procure benefit for themselves
(e.g. bribery).
Fraudulent Financial Statements – involves the
. omission of material
intentional misstatement or
information in financial reports.
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Prevalence of Fraud
and Dollar Losses
Occupational Frauds by Category1
Asset Misappropriation
Corruption
Fraudulent Statements
86.3%
32.8%
Median
Loss
0%
$0
% of
Cases
$135,000
Median
Loss
0%
0%
4.8%
$0
% of
Cases
$250,000
0%
Median
Loss
$0
% of
Cases
$4,100,000
1
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“2010 Report to the Nations On Occupational Fraud & Abuse”, ACFE, 2010, p.11
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Asset Misappropriation
Fraud Schemes
Billing
Schemes
Payroll
Schemes
Expense
Reimbursement
Schemes
Check
Tampering
Register
Disbursements
3.0%
26.0%
8.5%
Larceny
Skimming
Skimming
Cash Larceny
Understated
Sales
From the
Deposit
Receivable
Write-offs
Non-Cash
Theft
Lapping
Schemes
38.7%
14.5%
15.1%
13.4%
*Sum
of percentages exceeds 100% because many cases involve multiple schemes
Figures From: “2010 Report to the Nations On Occupational Fraud & Abuse”, ACFE, 2010, p.15
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What is AP Fraud?
Any fraudulent disbursements made by employees or
managers from company funds.
AP fraud Includes:
False billing
Payroll fraud
Fake expenses
Check tampering
Register disbursements
A form of asset misappropriation (along with theft,
embezzlement, skimming, etc).
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Fraud Triangle
Opportunity – This relates
to the position held by the
individual and the controls
in the organization.
Rationalization – Some
kind of justification, like
“everyone is doing it,” “I
need the money,” or “the
company owes me this.”
FINANCIAL
PRESSURE
Pressure – Reason to commit fraud.
In AP fraud this will usually be
personal financial need or greed.
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Who is Committing Fraud?
Outsiders, insiders, organized criminals, related
third-parties.
Fraudster profile(s):
First time offender (85%)1. This is inflated by the inability of many fraudsters
to re-offend due to loss of status.
Most defendants in fraud cases are white males of moderate social status.
They are slightly more likely to be both high school and college educated.
The typical offender is married with a stable family situation.
Offenders are often long-time employees.
Many offenders have experienced recent sudden change in
personal circumstances.
Asset misappropriations (which includes AP fraud) are most likely to be
committed by lower-status, middle-class individuals.
1“2010
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Report to the Nations On Occupational Fraud & Abuse,” ACFE, 2010, p.5
© 2011 FTI Consulting, Inc.
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Overview (Cont’d.)
Introduction to Fraud
Red Flags
Detection, Prevention
and Controls
Case Study
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Page 11
Red Flags — Behavioral
Top behavioral red flags associated with
asset misappropriation schemes1:
Behavioral Flags of Perpetrators (2010)
Living beyond means
43.0%
Financial difficulties
36.4%
Control issues, unwillingness to share duties
22.6%
Unusually close association with vendor/customer
22.1%
Wheeler-dealer attitude
19.2%
Divorce/family problems
17.6%
Irritability, suspiciousness or defensiveness
14.4%
Addiction problems
11.9%
Refusal to take vacations
10.2%
Past employment-related problems
9.3%
Complained about inadequate pay
7.9%
19.4%
0%
1“2010
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50%
Report to the Nations On Occupational Fraud & Abuse,” ACFE, 2010, p.29
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Red Flags —
Managerial Environment
Lack of cooperation with auditors.
Management decisions dominated by one individual or
a small group.
Weak internal control environment.
Excessive number of checking accounts.
Decentralization without adequate monitoring.
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Red Flags — Accounting
and Transactions
Unusual payment patterns – round dollar, duplicates,
irregular invoice activity or volume.
Abnormal number of expense items, supplies, or
reimbursement to the employee.
Excessive or unjustified cash transactions.
Sudden activity in dormant banking accounts.
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Red Flags — Accounting
and Transactions (Cont’d.)
Vendor addresses: non-physical addresses, same as
employee addresses, or strange address changes.
Employee records: duplicate addresses or SSNs,
changes to employee details, lack of taxes.
Banking addresses: common tax & money
laundering havens.
Voided or missing checks.
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Overview (Cont’d.)
Introduction to Fraud
Red Flags
Detection, Prevention
and Controls
Case Study
www.TheAPNetwork.com
© 2011 FTI Consulting, Inc.
Page 16
Detection of Frauds
Initial Detection of Occupational Frauds1
40.2%
Tip
15.4%
Detection Method
Management review
13.9%
Internal audit
8.3%
By accident
Account reconciliation
6.1%
Document examination
5.2%
External audit
4.6%
Surveillance/monitoring
2.6%
Notified by police
1.8%
Confession
1.0%
IT controls
0.8%
0%
Percent of Cases
1“2010
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50%
Report to the Nations On Occupational Fraud & Abuse,” ACFE, 2010, p.16
© 2011 FTI Consulting, Inc.
Page 17
Prevention and
Controls — Fraud Triangle
Reduce opportunity –
good controls and
controlled environment
lower opportunity
and the perception
of opportunity.
Try to make rationalization
less likely by increasing
employee buy-in
with company ethics and
mission.
FINANCIAL
PRESSURE
Be cognizant of pressure – internal
pressures (e.g. payment structure)
and external pressures (e.g.
personal financial struggles).
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Prevention of
Fraud — Work Environment
Establish code of conduct, anti-fraud policy, and
employee training.
Encourage employee “buy-in” – people who align
themselves with the firm are less likely to defraud it.
Create strong control environment/strong “tone at
the top.”
Facilitate easy vertical communications.
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Prevention of
Fraud — Internal Controls
Fraud hot lines for reporting suspected cases. 47.1% of
all occupational fraud is detected via a tip1.
Segregation of duties.
Move away from the use of checks for payment – move
to ACH and card payments.
Segregation of bank accounts by activity.
Enforce holidays or rotation of duties for AP staff.
Regular analytical reviews – actual vs. budget and
actual vs. historical.
Effective use of software.
1 “2010
www.TheAPNetwork.com
Report to the Nations On Occupational Fraud & Abuse,” ACFE, 2010, p.16
© 2011 FTI Consulting, Inc.
Page 20
Frequency and
Effectiveness of Controls
Median Loss Based on Presence of Anti-Fraud Controls1
Control
% of Cases
Implemented
Control In
Place
Control Not
in Place
%
Reduction
Hotline
48.6%
$100,000
$245,000
59.2%
Employee Support Programs
44.8%
$100,000
$244,000
59.0%
Surprise Audits
28.9%
$97,000
$200,000
51.5%
Fraud Training for Employees
39.6%
$100,000
$200,000
50.0%
Fraud Training for Managers/Execs
41.5%
$100,000
$200,000
50.0%
Job Rotation/Mandatory Vacation
14.6%
$100,000
$188,000
46.8%
Code of Conduct
69.9%
$140,000
$262,000
46.6%
Anti-Fraud Policy
39.0%
$120,000
$200,000
40.0%
Management Review
53.3%
$120,000
$200,000
40.0%
External Audit of ICOFR
59.3%
$140,000
$215,000
34.9%
Internal Audit/FE Department
66.4%
$145,000
$209,000
30.6%
Independent Audit Committee
53.2%
$140,000
$200,000
30.0%
Management Certification of F/S
58.9%
$150,000
$200,000
25.0%
External Audit of F/S
76.1%
$150,000
$200,000
25.0%
Rewards for Whistleblowers
7.4%
$119,000
$155,000
23.2%
1 “2010
www.TheAPNetwork.com
Report to the Nations On Occupational Fraud & Abuse,” ACFE, 2010, p.29
Page 21
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Response to
Suspicion of Fraud
Written response policy – who is responsible, who will
be involved, procedures for evidence gathering,
disciplinary procedures.
Is there suspicion of money laundering? If yes,
immediately seek counsel.
Consider using outside consultants to investigate –
especially if the amounts involved are material to your
company’s financial statements.
How can you learn from the incident and avoid it
happening again?
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Overview (Cont’d.)
Introduction to Fraud
Red Flags
Detection, Prevention
and Controls
Case Study
www.TheAPNetwork.com
© 2011 FTI Consulting, Inc.
Page 23
The Situation
A review of accounts payable records during an audit
revealed two checks with no supporting documentation
totaling more than $190,000.
The checks were made payable to the AP clerk and
another individual not recognized by the company.
We were called in by the company’s outside
employment lawyers in an effort to evaluate the extent
of the problem…
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The Victim
$200M privately held
manufacturing concern.
Many long-term employees.
Turmoil and upheaval in the
accounting department.
Recently sold to new investors.
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The Investigation
Isolation of computers and
email accounts.
Background checks and
review of personnel files.
Request for bank records.
Extensive review of AP
disbursements, checks and
vendor lists.
Interviews of personnel.
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Initial Findings
11 days after being
hired, her
compensation
increased dramatically!
Date of Check
Amount
16 Sep 2004
$5,653.44
10 Oct 2004
$8,258.11
18 Nov 2004
$99,987.96
9 Dec 2004
$9,259.77
29 Dec 2004
$10,190.06
14 Apr 2005
$123,966.00
14 Apr 2005
$10,190.52
3 Mar 2005
$3,773.84
17 Mar 2005
$6,600.68
17 Jun 2005
$12,599.10
20 Jul 2005
$95,000.00
18 Aug 2005
$94,636.28
27 Oct 2005
$15,478.57
TOTAL
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$495,594.33
Page 27
The Fraud
AP clerk took advantage of
controls weaknesses,
including superior’s failure to
perform job duties, and began
printing manual checks to
herself and an unknown
individual, “Brad Harman.”
She resigned and left
the company more than a
month before the fraud
was discovered.
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Subject Profile
Female
Single, under 30
New employee
Prescreened (?) by temp agency
Background check revealed only a traffic violation
No history of financial problems
Previously worked in a bank
Educated (B.S. in accounting, working towards a
Masters at a prestigious university)
Religious
Lesson: Don’t rely too much on profiles or statistics
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The
Investigation - Expanded
Continued review of the payables
disbursements revealed some
concerning issues.
Numerous checks made out to
petty cash, unknown vendors
and to another individual whom
the company also recognized…
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The AP Manager Who Supervised
the AP Clerk: Subject #2
Over the course of five years took
between $160,000 and $200,000.
More than 100 separate checks
ranging from $100 to $6,800.
Altered miscellaneous cash
accounts, voided checks, even
faked enrollment in school to
conceal fraud.
Lesson: Fraud schemes are always bigger than they first appear!
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Profiling Revisited
Subject #1
(AP clerk)
Subject #2
(AP Manager)
Female, under 30
Female, over 40
New employee
15-year employee
Prescreened (?) by temp agency
Never screened or checked
Background check revealed only a
traffic violation
Background check would reveal
no significant criminal history
No history of financial problems
Significant financial problems
Previously worked in a bank
Never had another job
Educated (B.S. in accounting,
working towards a Masters at a
prestigious university)
Barely finished high school
Rough around the edges
Religious and polished
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Additional Resources
• Association of Certified Fraud Examiners (ACFE)
― http://www.acfe.com/resources/publications.asp
• Association for Financial Professionals (AFP)
― http://www.afponline.org/pub/res/topics/topics_pay.html
• American Institute of CPAs (AICPA)
― http://www.aicpa.org/INTERESTAREAS/FORENSICANDVALUA
TION/RESOURCES/FRAUDPREVENTIONDETECTIONRESPO
NSE/Pages/default.aspx
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